PE Fundraising: Best Practices for Sizing a Debut Fund

Becoming a general partner (GP) at a private equity firm is a significant milestone in your M&A career. It represents a new level of responsibility and the opportunity to shape the future of your firm. 

One of the most critical decisions you'll face as a new GP is determining the size of your first fund. Sizing your fund appropriately is crucial for success, as it sets the stage for your firm's growth and reputation within the industry. 

Grata recently hosted a panel of limited partners (LPs) and their advice to emerging managers was this: Envision yourself in the meeting with LPs. How do you answer the question: “How did you come up with that fund size? How do you bridge the gap from past experience to future ambitions?”

Here are some steps to help get you to the right fund size.

Define Your Investment Strategy

Before deciding on the fund size, you must have a clear understanding of your investment strategy. 

Consider the following questions:

a. What sectors or industries will you focus on?

b. What is your geographic scope?

c. Will you pursue a particular investment stage (early-stage, growth, distressed, etc.)?

d. Do you have a unique value proposition or competitive advantage?

Your investment strategy should guide your fund size. For example, if you plan to invest in high-growth technology startups, you may need a smaller fund initially. However, if you aim to target larger acquisitions in mature industries, a larger fund may be necessary.

Starting Smaller Can be Better

During the October 2023 panel discussion, industry experts Sheryl A Mejia and Agata Rzamek Praczuk shared valuable insights into the considerations involved in sizing a debut private equity fund. 

They emphasized the importance of intentionality in every decision made, including fund size. 

Sheryl Mejia, Managing Partner, Steward Asset Management noted that in buyouts, it's common to see 8-10 deals done in the first fund. All 8 deals do not need to be lined up prior to the fund close, but LPs will expect to see a sample of the targets you are looking to acquire.  

Here are two considerations for buyout PE funds to consider:

1. Investors evaluate a GPs track record and the size of the best deals within that track record to determine an appropriate fund size. 
2. For debut teams, sometimes starting with a slightly smaller fund size can be beneficial, especially if GPs have attractive deals and want to penetrate a less competitive segment of the middle market.

Making the Pitch

Agata Rzamek Praczuk, Director of Emerging Managers Program at MetLife Investment Management emphasized the importance of crafting a compelling narrative when pitching fund size to LPs. 

She encouraged fund managers to picture themselves in the meeting with LPs. How would you answer the question, “How did you get to this fund size?”  

GPs need to bridge their past experiences with their future ambitions, ensuring that the fund size makes sense in the context of their track record. What was the largest deal size you managed in your last role? What about your partners? LPs expect to see the reasoning behind how you derive your first fund number.

Additional Factors to Sizing Fund One

Remember that fund size is not set in stone; you can adjust it in subsequent funds based on your performance and the evolving needs of your firm and LPs. Here are some additional factors to consider:

Assess Market Conditions

The state of the private equity market plays a significant role in determining fund size. 

Factors to consider include:

a. Fundraising environment: Are LPs (Limited Partners) willing to commit capital to new funds?

b. Competitive landscape: How many other PE firms are targeting similar investments?

c. Deal flow: Is there a sufficient pipeline of opportunities that fit your strategy?

d. Economic conditions: How might economic trends impact your investments?

During favorable market conditions, LPs may be more willing to invest, allowing you to raise a larger fund. However, in challenging times, you may need to be more conservative in your fund size to ensure you can deploy capital effectively.

Calculate Your Operational Costs

Running a private equity firm incurs various operational costs, including salaries, office space, legal and compliance fees, and marketing expenses. You must estimate these costs and allocate a portion of your fund for operating expenses. Typically, this can range from 1% to 3% of the total fund size annually.

Consider Your LP Base

The composition of your LP base can influence your fund size. If you have a strong network of high-net-worth individuals or family offices, you might raise a smaller fund initially. On the other hand, if you secure commitments from institutional investors such as pension funds or endowments, they may expect a larger fund size.

Determine Your Target Investments

Consider the size of the investments you intend to make. If your strategy involves making numerous smaller investments, you may need a smaller fund. Conversely, if you plan to pursue larger deals, you'll need a more substantial fund to accommodate these transactions.

Fundraising and Deal Sourcing Capacity

As a new GP, your fundraising capabilities will be untested. Be realistic about your ability to raise capital and set a fund size that aligns with your network, experience, and track record. It's often easier to raise a smaller fund initially and seek growth in subsequent funds as your track record improves. 

Actively deal sourcing prior to your fund closing is crucial, but also time consuming. New GPs need to prioritize their day-to-day work to include fundraising networking and meetings alongside sourcing networking and meetings. 

Often, the two go hand-in-hand two ways to start are to 

1) Attend industry events, conferences, and networking functions to build relationships with potential deal sources, including entrepreneurs, business owners, investment bankers, and other intermediaries and 

2) Leverage your existing network and connections to identify potential investment opportunities.

Regulatory and Compliance Considerations

Different jurisdictions may impose regulatory and compliance requirements that can impact your fund size. Ensure you understand the legal and regulatory obligations associated with fund management in your chosen location.

Hear Directly from LPs 

In October 2023, Grata hosted a webinar with LPs from Steward Asset Management and MetLife where they shared tactical advice for a debut fund raise. Download the recording.